Analyzing the Impact of Informal Labor Sector Regulation in the Context of International Trade: A Theoretical Approach

I analyze the relationship between international trade and welfare using a theoretical model of heterogeneous firms with a labor market segregated between informal and formal firms. The segregation in this case is a result of the introduction in the market of a regulatory threshold, according to which firms having less than a certain quantity of workers are defined as informal, otherwise they are formal and should pay additional fixed and marginal labor costs. This threshold creates a situation where it is endogenously more profitable for the most productive informal firms to scale back production to avoid formal labor costs. The numerical solution of the model shows that, after trade openness, a share of the most productive informal firms become less productive informal, and that the less productive formal firms become most productive informal. The welfare in the economy decreases because of the shrinking of firms, the higher prices, and the reduction of available varieties. Likewise, the comparative static exercise yields evidence that a decrease in the regulatory threshold forces informal firms to become formal; therefore, under full employment conditions, such a policy increases all average wages and raises welfare.